Introduction to Corporate Finance

16: Financial Planning

In this chapter, we have emphasised the importance of financial planning and illustrated a few of the

most widely used tools of the trade. We end with a word of caution. When companies construct financial

plans, they clearly hope to meet the plans’ goals. However, the value of planning is not just in attaining

established goals; rather, its importance derives from the thinking it forces managers to do – not only

about what they expect to occur in the future, but also about what they will do if their expectations are

not realised.

6 Suppose that a company follows the matching financing strategy. Does this imply that the

company’s current assets will equal its current liabilities?

7 Why do companies prepare cash budgets? How do (a) collection patterns and (b) payment patterns

affect the cash budget?

8 What can be done to deal with uncertainty in the cash budgeting process? Why might an intra-

month view of the company’s cash flows cause a well-prepared cash budget to fail?

CONCEPT REVIEW QUESTIONS 16-3

What impact would offering

customers more generous credit

terms have on the cash budget?

thinking cap

question

SUMMARY

■ Strategic (long-term) financial plans guide

companies in preparing operating (short-

term) financial plans. For most companies,

strategic plans are driven by competitive

forces that are not always explicitly financial

in nature. However, strategic plans have

important financial consequences.

■ The finance function partners with

other functional units in developing

the company’s strategic plan. Once the

company establishes the plan, finance

personnel ensure that the plan is feasible,

given the company’s financial resources.

Finance personnel also play a crucial role in

monitoring progress and in managing risks

associated with financial plans.

■ Most companies strive to grow over time.

Popular measurements of growth include: (1)

achieving accounting return on investment

(ROI) in excess of the cost of capital; (2)

undertaking only actions that result in

positive economic value added (EVA); and

(3) realising a target growth rate in sales or

assets. Target growth rates are widely used

because of their intuitive, computational and

practical appeal.

■ The sustainable growth model is a tool that

is used to determine the feasibility of a

target growth rate under certain conditions.

When the growth rate that maximises

shareholder value does not match the

sustainable rate, the company must make

adjustments to the model’s inputs – such

as altering leverage or dividend policy – to

achieve the desired growth rate.

■ Pro forma financial statements are projected,

or forecast, financial statements typically

based on historical financial data about the

company. Preparation of these statements

begins with a sales forecast that can be

developed by using a top-down or a

bottom-up approach or a blend of these

two approaches. The key inputs to pro

forma statements are a mix of facts and

assumptions.

■ Companies can prepare pro forma

statements using the percentage-of-sales

method, which assumes that all items grow in

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